Press Release Economic Policy United States

Fed Faces Risk of Overshooting on Rate Hikes, Says CEPR Economist

June 15, 2022

Contact: KL Conner, 202-281-4159Mail_Outline

Washington — CEPR Senior Economist Dean Baker responds to the federal fund rate hike announced today by the Federal Reserve Board:

“The Federal Reserve Board’s decision to raise the federal fund rate by 0.75 percentage points was a reasonable response to the inflation we have been seeing over the last year. However, if the Fed continues on a path of aggressive rate hikes, there is a serious risk that it will thrust the economy into a recession, needlessly pushing millions of people out of jobs.

“As is well understood, much of the inflation we now see stems from factors that have little to do with the strength of the US economy. The soaring price of oil is due to Russia’s invasion of Ukraine and subsequent sanctions. Fed rate hikes will not bring down the price of gas. There is a similar story with the price of wheat and other grains, where Ukraine is a leading exporter.

“In other areas, most notably vehicles, we continue to see supply chain disruptions associated with the fire in a semiconductor factory in Japan. In some areas, where we saw large run-ups in prices, such as televisions and appliances, prices are now falling.  This pattern is likely to spread more widely in the goods sector as excess supply leads to large markdowns.

“The Fed’s rate hikes have already had a huge hit to the housing market, with purchase mortgage applications down more than 15 percent even before the run-up in interest rates this week. This will not only end the excessive rate of house price increases we have seen over the last two years, but it will also have a large spillover effect on other areas of the economy.

“The demand for new appliances that typically follow a house purchase is likely to fall sharply. The refinancing market has virtually disappeared. This not only cuts off what had been an important source of credit for millions of households, it also eliminates a source of economic activity, as households had been spending tens of billions annually on refinancing fees.

“It is also important to note that average hourly wage growth has already slowed sharply. Comparing wage growth over three-month periods, the annual rate of wage growth peaked last year at 6.1 percent. (This annualizes the rate of wage growth between August, September, October and November, December, January.) In the most recent period (December, January, February to March, April, May), the annual rate was just 4.4 percent.

“This is just a percentage point faster than the year-round average for 2019 — a year when the core Personal Consumption Expenditure deflator increased by just 1.6 percent, 0.4 percentage points below the Fed’s target. More importantly, the direction of change for wage growth is downward, the wrong way for a wage-price spiral.

“Understandably, the Fed would want to raise rates to demonstrate its determination to keep inflation under control. It is also hard to justify a near zero federal funds rate when the unemployment rate is close to 50-year lows. However, there is a serious risk that the Fed will overshoot if it continues on this path.

“Fed Chair Powell is the first chair in recent decades to explicitly recognize the full employment side of the Fed’s dual mandate and note the huge benefits of low unemployment to Black and Hispanic workers, people with criminal records, and other groups disadvantaged in the labor market. In keeping with this recognition, the Fed would be well-advised to resist the frenzy of inflation fighters who want to see a whole series of large rate hikes.

“The Fed needs to assess the impact of the rate hikes it has already put in place and determine the extent to which further hikes are needed to keep inflation at acceptable levels.”

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